Recent Developments/ Buffets Shareholder Letter

Seems like not much has changed since my last post. As I am writing this I am listening to Kris Kristofferson one of my favorite song writers sing, "Nobody Wins". For those of you who do not know Kristofferson here is a link to an interview with him on the Colbert report:

http://www.colbertnation.com/the-colbert-report-videos/219952/february-26-2009/kris-kristofferson-pt--1

One person worth listening to is the Oracle. Like most he has taken a beating but unlike you andhe has about 27 Billion of cushion. Buffet has reached the point where he couldn't panic sell even if he wanted to so instead he spending his time ruminating over economic collapse he has been dreaming up little gems like “In God we trust; all others pay cash.” Unfortunately, the question is quickly becoming can we even trust in cash. My beliefs and bets like in the yes camp. Which is why like Buffet I have been locking up secure income streams to get me through the next couple years. In that light I recently increased my position in NLY which yields 14.4%.

BERKSHIRE HATHAWAY INC.
To the Shareholders of Berkshire Hathaway Inc.:

Our decrease in net worth during 2008 was $11.5 billion, which reduced the per-share book value of both our Class A and Class B stock by 9.6%. Over the last 44 years (that is, since present management took over) book value has grown from $19 to $70,530, a rate of 20.3% compounded annually.*

The table on the preceding page, recording both the 44-year performance of Berkshire’s book value and the S&P 500 index, shows that 2008 was the worst year for each. The period was devastating as well for corporate and municipal bonds, real estate and commodities. By year end, investors of all stripes were bloodied and confused, much as if they were small birds that had strayed into a badminton game.

As the year progressed, a series of life-threatening problems within many of the world’s great financial institutions was unveiled. This led to a dysfunctional credit market that in important respects soon turned non-functional. The watchword throughout the country became the creed I saw on restaurant walls when I was young: “In God we trust; all others pay cash.”
By the fourth quarter, the credit crisis, coupled with tumbling home and stock prices, had produced a paralyzing fear that engulfed the country. A freefall in business activity ensued, accelerating at a pace that I have never before witnessed. The U.S. – and much of the world – became trapped in a vicious negative-feedback cycle. Fear led to business contraction, and that in turn led to even greater fear.

This debilitating spiral has spurred our government to take massive action. In poker terms, the Treasury and the Fed have gone “all in.” Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel. These once-unthinkable dosages will almost certainly bring on unwelcome aftereffects. Their precise nature is anyone’s guess, though one likely consequence is an onslaught of inflation. Moreover, major industries have become dependent on Federal assistance, and they will be followed by cities and states bearing mind-boggling requests. Weaning these entities from the public teat will be a political
challenge. They won’t leave willingly.

Whatever the downsides may be, strong and immediate action by government was essential last year if the financial system was to avoid a total breakdown. Had one occurred, the consequences for every area of our economy would have been cataclysmic. Like it or not, the inhabitants of Wall Street, Main Street and the various Side Streets of America were all in the same boat.

Amid this bad news, however, never forget that our country has faced far worse travails in the past. In the 20th Century alone, we dealt with two great wars (one of which we initially appeared to be losing); a dozen or so panics and recessions; virulent inflation that led to a 211⁄2% prime rate in 1980; and the Great Depression of the 1930s, when unemployment ranged between 15% and 25% for many years. America has had no shortage of
challenges.

Without fail, however, we’ve overcome them. In the face of those obstacles – and many others – the real standard of living for Americans improved nearly seven-fold during the 1900s, while the Dow Jones Industrials rose from 66 to 11,497. Compare the record of this period with the dozens of centuries during which humans secured only tiny gains, if any, in how they lived.

Though the path has not been smooth, our economic system has worked extraordinarily well over time. It has unleashed human potential as no other system has, and it will continue to do so. America’s best days lie ahead.

Take a look again at the 44-year table on page 2. In 75% of those years, the S&P stocks recorded a gain. I would guess that a roughly similar percentage of years will be positive in the next 44. But neither Charlie Munger, my partner in running Berkshire, nor I can predict the winning and losing years in advance. (In our usual opinionated view, we don’t think anyone else can either.) We’re certain, for example, that the economy will be in shambles throughout 2009 – and, for that matter, probably well beyond – but that conclusion does not tell us whether the stock market will rise or fall.

In good years and bad, Charlie and I simply focus on four goals:

(1) maintaining Berkshire’s Gibraltar-like financial position, which features huge amounts of
excess liquidity, near-term obligations that are modest, and dozens of sources of earnings
and cash;

(2) widening the “moats” around our operating businesses that give them durable competitive
advantages;

(3) acquiring and developing new and varied streams of earnings;

(4) expanding and nurturing the cadre of outstanding operating managers who, over the years,
have delivered Berkshire exceptional results.

Berkshire in 2008

Most of the Berkshire businesses whose results are significantly affected by the economy earned below their potential last year, and that will be true in 2009 as well. Our retailers were hit particularly hard, as were our operations tied to residential construction. In aggregate, however, our manufacturing, service and retail businesses earned substantial sums and most of them – particularly the larger ones – continue to strengthen their competitive positions. Moreover, we are fortunate that Berkshire’s two most important businesses – our insurance and utility groups – produce earnings that are not correlated to those of the general economy.

The rest of the letter is an update on Berkshire's operating businesses

Garnett Keith's February Update

Garnett Keith is my boss at SeaBridge Investment Advisors, below is an update he wrote to some friends in Europe...

February 2009 Update

A year ago we were worrying about sub-prime mortgages. Then larger problems in SIVs and financial institution leverage rose to the top of the worry list. Libor soared and the banking community ossified. Then Lehman, FNMA, AIG, Countrywide, WAMU and Wachovia focused our attention on failures of specific institutions. Falling markets, massive withdrawals from mutual funds, and hedge fund forced selling made September through November extraordinarily painful. December had a hopeful rally, and then January dashed hopes. So where are we today? Are we not ready for a rebound in the equity markets?

Through the confusion and all this pain, the “how we got there” is becoming clear. The world’s structural financial problems shifted from two decades of emerging market borrowing crises to a decade plus of huge emerging market savings. The savings were recycled to the U.S., and interest rates were substantially suppressed. This liquidity flow and low interest rates sent the U.S. consumer on a borrowing binge; a libertarian government supplied too much credit and too little supervision; investment banks enjoyed massive increases in leverage; plentiful liquidity meant rising securities prices and casual attitudes about risk; and commercial banks became intoxicated with their new merchant banking and “originate and sell on” capabilities.

In this litany, there are a lot of problems to be fixed. I doubt we are entering a sustainable bull market until more of the fundamental problems have been fixed. What is the progress report?

• The Bush team stabilized the major banks and pushed the auto industry debacle forward to March 2009
• The Obama $787 billion Economic Stimulus package will cut middle class taxes, reduce hardship by extending unemployment benefits; will fix the Alternative Minimum tax problem; and will unleash other spending programs.
• The housing support package (Foreclosure Prevention Act), approved by the Senate this week attempts to slow the decline of house prices; gives cities money to purchase foreclosed homes, restores the depleted reserves of FNMA and Freddie Mac; and slow the eviction of defaulting homeowners by allowing the adjustment of mortgage terms.
• Secretary Geithner’s plan for restoring the financial sector is still under development. Reports are that it will encourage and finance private sector efforts to lift bad assets out of the banks, probably providing some ceiling on losses on purchased assets.

The problem with this combination of efforts is that they do not seem to be adequate to solve the problems in 2009. It appears that many of the problems will have to be worked out by debt reduction via defaults over time.

• At the head of the list of unsolved problems is the global imbalance. World trade is collapsing and domestic demand in the surplus countries will take years to offset the consumption swing in the U.S. Essentially, no consumer has been found to replace the tapped-out U.S. shopper and keep world production at its 2006-2007 level.
• The capital destruction numbers are grim. Jeremy Grantham calculates that 2008-09 losses of 50% on equities, 35% on housing, 35% on commercial real estate, destroy about $20 trillion of wealth from a starting number of $50 trillion. This compares to a $13 trillion economy and $25 trillion of corporate and individual private debt. As a result banks are rapidly trying to get more collateral and guarantees behind their loans. At elevated lending standards banks would like to reduce the $25 trillion of debt to $15 trillion. The pressure to reduce the other $10 trillion of debt is a major depressant on the economy.
• As U.S. spending falls, excess capacity and inventory cause layoffs, rising unemployment and a downward cycle of consumer confidence in the world-wide supply chain.
• With demand for both consumer and capital goods falling fast, export powers like China, Japan, and Germany are finding their economies falling far faster than anticipated.
• The second and third round multiplier effects of the global contraction will be moving through the global markets throughout 2009.

High level analyses being circulated from academe and think tanks, arrive at worrying conclusions that the proposals of governments, so far, provide much less stimulation than the negative forces being unleashed by a world wide contraction. For example, announced reductions in corporate capital spending plans exceed all currently discussed government stimulation plans. This means more and more pressure on global employment. In the consuming countries, unemployment puts heavy pressure on bank assets – defaulting credit card and prime mortgages in the U.S. and heavy losses on their Eastern European assets in European banks.

The most interesting statistics I have seen lately is from a paper from Wynne Godley at the Levy Institute (Prospects for the U.S. Economy and the World, December 2008.) It concludes that to restore balance, U.S. private sector debt needs to be reduced from 174% of GDP to roughly 130% of GDP between 2008 and 2013. This requires a savings shift from borrowing roughly 10-15% of GDP at the peak to saving roughly 5% of GDP for 5 years, 2009-2013. This equals roughly a $2 trillion a year savings increase on a $14 trillion economy ($10 trillion of consumption) for several years. A 20% U.S. consumption swing on a sustain basis requires a new world order or a global recession of large magnitude.

The Obama Economic Stimulus Act, even if one assumes it is 100% effective, is roughly $787 billion spread over two or more years. So the scale is mismatched in favor of continuing deflationary forces.

Debate now seems to be moving toward nationalizing major banks. This would allow an immediate “lift out” of bad assets (The Swedish solution) This probably has the best odds of fixing the banking system within 12 months. However, U.S. opinion still recoils from nationalization of anything, so there is a good chance we will apply the Japanese solution – banks struggle on for years – rather than the Swedish solution.

All these forces lead to major institutions ranging from Warren Buffett to Yale University to shift away from equities toward debt – especially investment grade debt until the problems are worked out. That thinking, of course, leads to lows in equity markets and very good equity values for those willing to look across the problems to an eventual recovery.

Equity commentators vary in their assessment of the odds for a sharp bear market rally. The composite scorecard looks something like:

Pluses:

1. There is huge liquidity on the sidelines which could push equities substantially higher if confidence were restored.

2. The Fed is making progress in fixing the capital markets and investment grade bonds have moved up significantly since November

3. The Baltic Dry Index has turned sharply higher signaling the beginning of recovery in China

4. There has been a huge increase of liquidity in China and the Shanghai market is moving higher.

5. Manufacturing orders around the world are declining at a less rapid rate.

6. Money supply in the U.S. has been growing rapidly, offsetting the fall in money velocity

Minuses

1. Bank profits will be negative in 2009 and industrial profit forecasts are still being downgraded

2. Industrial production, tech orders, and orders for durable goods are still falling

3. While optimistic earnings forecasts put P/E’s in the range of past bear market lows, there is very low confidence on what the E’s will be in a global recession of this magnitude. Pessimistic earnings forecasts show the S&P at over 25 times 2009 earnings

4. With $2 trillion of Government borrowing on the horizon, 10 year Treasury rates have moved significantly off their lows. The fear of stagflation is growing.

5. With the rebound in Treasury rates, the spike in mortgage refinancing – providing liquidity to the system – has collapsed again

6. The debate over nationalizing the banks and the auto companies will be very divisive

7. Unemployment will likely rise from 7.6% to 9% during the course of 2009. While a lagging indicator, this will weigh on confidence.

8. Until there is a credible plan to fix the banks, money will stay on the sidelines.

Within the Yield Growth portfolios we continue to increase our focus on “reliable income streams.” These include significant positions in MLP’s, in Government Guaranteed mortgage REITS, and in corporate bond funds – especially closed end funds trading at a discount. We have begun buying some individual investment grade corporate bonds in the PIM Yield Growth SICAV where bond fund holdings are limited. With more and more fixed income, portfolio yields are at highs.

The Ascent of Money

I began reading The Ascent of Money by Niall Ferguson. Below is a review by John M. Mason that I think is informative....

Niall Ferguson has been getting a lot of press recently. Apparently he made a big impression on people in Davos at the recently held conference, and he has followed up on this publicity with a column in the Financial Times, where he is a contributing editor, and a blog on The Huffington Post. The basic idea Ferguson is presenting to the world is that the underlying problem in the financial crisis is too much outstanding debt. He says that rather than add more debt, through government stimulus programs, to the toxic waste that currently exists, policymakers should develop a plan that would actually reduce leverage, i.e. reduce the amount of debt outstanding.

He is highly critical of the “born-again” Keynesians who have taken the writings of Keynes out of context and applied them to a situation that is not appropriate. Hence, to Ferguson, those countries enacting “Keynesian” stimulus plans will be exacerbating the current financial problem and not solving it.

Ferguson's recent book “The Ascent of Money” is not only a very worthwhile read, but it also provides some of the history and background to his policy conclusions. For either reason - or both - I would highly recommend this book to the reader of this blog.

Getting away from the “current events” application of this book, there are several other important lessons in history that Ferguson would like us to consider, making the book not only provocative, but supportive of financial institutions and those that work in the finance field. Seldom today, do you see such a defense raised.

First, Ferguson takes on the work of those utopian writers who consider the ideal world to be one in which there is no money, no finance. He concludes that modern, successful economies have a well developed money system and effective financial institutions that contribute to economic innovation and growth. Those societies that do not have a functional money system and no financial structure are the ones that do not grow and develop; this includes areas or regions (e.g. urban areas and agricultural regions) as well as nations. He contends that before the Industrial Revolution could take place in the West, there first had to be a financial revolution.

Ferguson then presents a discussion of why finance and financiers have such a “bad” reputation and are so easily picked upon when something goes wrong. For one, he argues, “debtors have tended to outnumber creditors and the former have seldom felt very well disposed towards the latter.” Also, “financial crises and scandals occur frequently enough to make finance appear to be a cause of poverty rather than prosperity, volatility rather than stability.” And, finally,

“for centuries, financial services in countries all over the world were disproportionately provided by members of ethnic or religious minorities, who had been excluded from land ownership or public office but enjoyed success in finance because of their own tight-knit networks of kinship and trust.”

The book makes three other points. One has to do with the fact that finance is often looked upon as a parasite to the “real” activity that goes on in the world, contributing little to the actual production of goods and services. The second is that financial systems seem to “reflect and magnify” what human beings are really like. That is, money

“amplifies our tendency to overreact, to swing from exuberance when things are going well to deep depression when they go wrong…But finance also exaggerates the differences between us, enriching the lucky and the smart, impoverishing the unlucky and not-so-smart.”

A third point deals with the seeming contribution of finance to tremendous amounts of wealth and to skewed income distribution, which has raised suspicions that finance is a parasite to “real” economic activity and contributes to the violent swings that take place within the economy - the assumption being that “real” economic activity would be more stable and less volatile without finance around.

There is one other key element to Ferguson’s world view. Ferguson does not believe in economic determinism; that is, he does not think that all decisions are made using rational economic reasoning. He believes that politicians and political events, especially wars, shape the institutions and policies, the rules and regulations, of modern economic life. In pure economic theory these inputs are treated as “exogenous” shocks, events that occur outside of our economic models but that significantly affect the future path of the economy.

What are these exogenous shocks? Well, how about a taxcut for the wealthy? How about a war on terrorism? How about a policy of keeping “real” short-term interest rates negative for over a year and a half? How about “domestic political conflicts” that arise relating to religion or other factors that can divide a nation -- say, cultural wars that relate to abortion, stem-cell research, and same-sex marriage? Ferguson contends that there is nothing in economics that can specifically account for these types of events and yet they play a major role in determining the evolution of an economy.

The body of the book is about the subtitle: A Financial History of the World. This may be a bit of a stretch, but he does cover a lot of history. There is a chapter on the history and evolution of the bond, a chapter on the rise of the joint-stock, limited-liability company and stock markets, a chapter on insurance and insurance companies and a chapter on the development of the idea of home ownership and whether or not home ownership should be a universal dream.

And then there is a chapter that moves us up to April 2008, when the book was being finished. The focus of this chapter is on “Chimerica”, the co-evolution of China and America in this current age of globalization. This chapter is worth reading even though a lot has happened since the author wrote the book. Of course, this leads into a discussion of all the debt that America has recently put on the books, and how this debt has been financed by nations that are just emerging into the modern financial system, dominated by China.

The rest of the story remains to be written -- and Ferguson, I’m sure, will contribute to its writing. Read this book. Read Ferguson’s earlier book “Cash Nexus: Money and Power in the Modern World, 1700-2000.” I believe that his ideas are going to be much discussed, and rightfully so. Having consumed these two books, as well as his several others, will give you a leg up on those discussions.

Annaly Update

I purchased Annaly, in Aug 08, it has been a solid performer. In December 08, I sold April 16 calls against half the position. The stock currently trades at 14.43. Annaly is poised to continue performing well considering the steepening of the yield curve. In a nutshell, Annaly borrows at Fed Funds and buys Agency-backed mortgages. Annaly is moderately leveraged at 7X. The biggest risk to our NLY ratings is that the Fed would resume its tightening campaign at some point in the next 12 months however I find that most unlikely given recent rhetoric. The stock is in a good trading range. If I can get some premium I may write calls against the rest of the position. I will look to exit around 17 if possible.

Comments from BCA Research

The recession is deepening, in terms of key consumer indicators such as employment and spending. Some surveys are showing that sentiment has bounced a bit, albeit insignificantly relative to the plunge in the second half of 2008. Importantly, leading economic indicators are still pointing down, as are leading gauges for inflation.

Against this backdrop, policymakers are going all out to support the financial system and provide some fiscal stimulus. So far the results are unimpressive in terms of easing lending standards or lowering private sector borrowings rates. Our expectation is that the authorities will continue to provide stimulus until the economy stabilizes, but this could still take some time and any recovery will be slow to develop.

The fed funds rate will hover at zero until the economy has decisively gained momentum and the credit creation process has been restarted, i.e. at least through to the end of 2009. The recent rebound in Treasury yields has been driven by fiscal angst and inflation fears, both of which should diminish in the coming months because higher yields reduces the odds of economic recovery. The Fed may soon purchase Treasurys if yields keep rising. In terms of fixed income sectors, we still prefer those credit areas where the government is providing direct support, as well as higher-quality corporate bonds.

For stocks, the slide in earnings and lack of positive guidance remain powerful headwinds. Good value and policy stimulus suggest that the late-2008 low should hold, but a sustained rally awaits some glimmers of economic hope. Most likely, a volatile bottoming phase will occur, similar (but longer lasting?) to the environment after the crash of 1987. Only a gradual nibbling in favored equity sectors is recommended.

Will Mr. Bernanke continue following the monetary policies of Zimbabwe???

I am tired of socialism for the rich and capitalism for the poor. It is an incredibly difficult time to be an investor right now. There are so many moving parts. All negative and the government is involved in each.

In a nutshell, after 2001 interest rates were to low for too long giving incentive to people to take risk. The major investment banks were on board as usual this time selling bundles of mortgages and credit card debt. A whole new market for credit default swaps was created. Debt rose to never before witnessed levels and finally the music stopped in 07 and the bankers went scrambling for their chairs. In Nov libor was 750 basis points. Capitalism was in cardiac arrest.

The proper thing to do at the time would have been to nationalize the banks. Wipe out the shareholders, keep the good assets and shed the bad assets at distressed prices. That however requires pain something nobody wants. As a result, the opposite happened and a 700 billion TARP fund was created to address a problem requiring trillions. Over half of TARP 1 has been squandered.

Now we have Obama in office. He has Volcker who is qualified. The problem isn't in the leaders its the system. Obama promised everyone and their brother something to get elected. Nobody in Washington wants to sacrifice. Everyone has a special interest group lobbying on their behalf. The current fiscal stimulus proposal is loaded with back ended government programs that won't have an impact for at least 18 months.

Policy makers have created the sense of urgency we are now experiencing by slowly throwing money on a fire that got completely out of control because they weren't watching it in the first place.

I am confident America will come through this because of loyal taxpayers like myself and the Chinese government who whether they like it or not are inextricably tied to America. The US policy makers actions may ease the pain near term but will likely limit long term growth and produce drastic inflation and higher taxes down the road.

In the words of my mentor On We Go...

Aegean Maritime

Aegean Marine is a volatile small cap bunkering company based in Greece. The stock was trading at 6 a year ago, jumped to 44 in the spring and has since pulled back to 17. The business model is resilient because the company doesn't transport cargo and therefore isn't exposed to day rates. Aegean is in solid financial position and well poised to purchase some mom and pop operations. I will continue to look into this company. If anyone is familiar with Aegean please share...

Greenlight Re

Thoughts Greenlight Re (GLRE)

My dad came in contact with Einhorn in the late 90's. Both were pushing for change at a small European paper company, Mercer International. It didn't take long for my dad to know Einhorn is shewd, honest and willing to ask management the right questions. Needless to say, he has been since been invested with Einhorn's hedge fund Greenlight Capital. I stumbled across Greenlight Re and after further investigation decided to invest.

The article below published by The Manual of Ideas although a bit of a sales piece does a good job of explaining why Greenlight is likely a good investment at these levels.

INVESTMENT THESIS — STRONG DOWNSIDE PROTECTION

An investment in Greenlight Capital Re (GLRE) should outperform the market in times both good and bad, due to David Einhorn’s superior investment skill and Greenlight’s strategy of selling stocks short in addition to buying them. We estimate fair value at $18-24 per share, based on the analysis presented in this report.

39-year-old David Einhorn has had phenomenal success managing Greenlight Capital (not the same legal entity as Greenlight Capital Re), a value-oriented hedge fund that has grown into a billion dollar firm from humble beginnings, with only $1 million in assets in 1996. While returns have suffered this year, we estimate that Greenlight has delivered an annualized return since inception, net of all fees and expenses, of more than 20%. This is an impressive feat considering that the fund navigated through both the bursting of the Internet bubble in 2001-02 and the ongoing U.S. credit contraction and recession. Also impressive is the fact that Einhorn achieved such returns while maintaining relatively low net exposure to equity markets, due to a strategy of buying undervalued stocks and selling short overvalued, mismanaged or downright fraudulent companies.

Greenlight Re went public in May 2007 as a publicly traded version of Einhorn’s hedge fund, with several enhancements:

• Tax-advantaged structure by virtue of Cayman Islands domicile, making Greenlight Re a pass-through vehicle for U.S. investors.
• Reinsurance underwriting should add value, an aspect that is unique to Greenlight Re as compared to Einhorn’s hedge fund. Underwriting is conservative, with significant unutilized capacity and most premiums related to frequency rather than severity business.
• Investors may sell their shares in the open market at any time, a liquidity benefit not available to hedge fund investors.
• Repurchases should accelerate growth of per-share value, as Greenlight Re may buy back stock at a discount in times of market distress. The Board authorized a two million-share buyback in August.
• Investors should benefit from price-to-book multiple expansion over time, as the market comes to appreciate Einhorn’s investment skill. This may allow investors buying at current prices and selling in the future to get paid for the discounted value of Einhorn’s “alpha.”

Einhorn is incentivized to grow shareholder value, as he owns 17% of Greenlight Re. He also has a track record of fair treatment of investors.

We judge Greenlight Re shares to have superior downside protection due to (1) their discount to book value, (2) Einhorn’s proven ability to generate investment outperformance, (3) a conservative underwriting posture, (4) an ability to repurchase shares below fair value, thereby limiting the downside and increasing future upside, and (5) an ability to go long as well as short in the stock market, enabling Greenlight to seize opportunities regardless of overall market direction.

Can We Please Nationalize These Banks?

As a United States taxpayer I am not pleased with the progression of the bailout to date. The first TARP fund has largely been squandered. I commend Bernanke for thinking outside the box however the American public was unprepared to quickly accept his prescriptions and therefore he was a bit constrained.

As an outsider analyzing the situation, it has become rather evident to myself and other economists most notably those concerned with reality including Roubini, Shiller and the likes that the US banking system is effectively insolvent. The best course of action is to follow Sweeden, nationalize the banks, differentiate between good and bad assets, and ensure that the necessary regulatory stops are put in place. Once that is completed in a couple years sell the assets to the private sector. Perhaps the term bridge bank is more fitting.

Proshares Ultrashort Barrons One-Day Wonders Report

Something to look into before purchasing a Proshares Ultra ETF. The performance of some leveraged funds, including China ultrashort, is based on only the DAILY performance results of the underlying index, not long-term returns. Let's say Index A goes up 10% on Day One, then drops 9% on day two, for a two-day return of about 0%. On Day One, a leveraged short fund based on this index would go down 20%. On Day Two, it would jump 18% (two times the index's 9% drop). But because that rise would be from a base equaling only 80% of your original investment, you would now have less than 95% of whatever you had anted up. In other words, while Traditional Index A broke even, the UltraShort Index lost 5.6%.

United States Finding Its Way Again

Below is Dr. John Hamre of the Center for Strategic and International Studies latest memo...

Washington is unusually vibrant these days because of the upcoming change of government. Announcements are made every day about new people coming into office, and messages come of current public servants who are returning to private life. But this year seems bigger than usual. There is a sense that we are at a fundamental turning point in American politics.

Government these days seems very important and fresh. This sense of enormous moment draws me to reflection, and that in turn takes me back to a fabulous little speech that Senator Bob Dole gave back in 1997. He had been defeated by President Bill Clinton, who in turn honored Senator Dole by bestowing on him the Presidential Medal of Freedom the following January.

At the awards ceremony, Bob Dole delivered one of the finest little speeches of the past half century. It is so good, that I am just going to share it with you in its entirety.

“Mr. President, no one can claim to be equal to this honor, but I will cherish it as long as I live, because this occasion allows me to honor some others who are more entitled.

“At every stage in my life, I have been a witness to the greatness of this country. I have seen American soldiers bring hope and leave graves in every corner of the world. I have seen this nation overcome depression and segregation and communism, turning back mortal threats to human freedom. And I have stood in awe of American courage and decency – virtues so rare in history, and so common in this precious place.

“I can vividly remember the first time I walked into the Capitol as a member of Congress. It was an honor beyond the dreams of a small town. I felt part of something great and noble. Even playing a small role seemed like a high calling, because America was the hope of history.

“I have never questioned that faith, in victory or in honest defeat. And the day I left office, it was undiminished. I know there are some who doubt these ideals. And I suspect there are young men and women who have not been adequately taught them. So let me leave a message to the future.

“I have found honor in the profession of politics. I have found vitality in the American experiment. Our challenge is not to question American ideals, or replace them, but to act worthy of them.

“I have been in government at moments when politics was elevated by courage into history—when the Civil Rights Act was passed, when the Americans with Disabilities Act became law. No one who took part in those honorable causes can doubt that public service, at its best, is noble.

“The moral challenges of our time can seem less clear. But they still demand conviction and courage and character. They still require young men and women with faith in our process. They still demand idealists, captured by the honor and adventure of service.

They still demand citizens who accept responsibility and who defy cynicism, affirming the American faith, and renewing her hope. They still demand the President and the Congress to find real unity in the public good.

“If we remember this, then America will always be the country of tomorrow, where ever
day is a new beginning and every life an instrument of God’s justice.”

Thank you, Bob Dole. These are remarkable days, and these wonderful words reflect what we all feel in our hearts. We are bound together in a common destiny. This must be a time for unified purpose.

Dr. Doom Weighs In...

Today I read Marc Faber's (gloomboomdoom.com) newsletter The January 2009 MMC

The title is amusing...

'The Future of Pessimism Has Never Looked Brighter'

Faber expects the market to rebound near-term but eventually sell off later in the year as additional poor economic data arrives.

He favors buying a basket of resource companies such as CVRD (RIO), Freeport McMoran (FCX), Newmont Mining (NEM), BHP (BHP), Rio Tinto (RTP), Oil Service Holders (OIH) and United States Oil Fund (USO) as they have been hammered in the second half of 2008 and the amount of money being printed should drive gold and other commodities up.

Recession, recovery, trade war and artificial life – welcome to 2009

Interesting link to what lies ahead in 2009. Published by the Financial Times...

http://www.ft.com/cms/s/13ee30ee-d66f-11dd-9bf7-000077b07658,dwp_uuid=73adc504-2ffa-11da-ba9f-00000e2511c8,print=yes.html

Puget Energy Finally Comes Through

The state regulators finally okay'd the merger. Here is a good article summarizing the process...

http://seekingalpha.com/article/112848-merger-review-puget-energy?source=yahoo

Comments from Nouriel Roubini

Below is Nouriel Roubini's latest. He was among the few who foresaw the recent turmoil in the markets. He is likely right in economic terms however the real question is has the market already discounted the slowdown ahead. My intuition tells me that we will likely see a good start to the year as there is a large amount of money on the sidelines and people coming into the markets after tax loss selling. However I suspect the markets will fade after that and the S&P could see an new low as investors come to terms with the depth of the cycle ahead. I have played the January bounce correctly however I suspect I will get out of the trade sooner rather than later as I believe the markets are poised to head lower.

Jan. 1 (Bloomberg) -- The global financial system in 2008
experienced its worst crisis since the Great Depression of the
1930s. Major financial institutions went bust. Others were bought
up on the cheap or survived only after major bailouts. Global
stock markets fell by more than 50 percent from their 2007 peaks.
Interest-rate spreads spiked. A severe liquidity and credit
crunch appeared. Many emerging-market economies on the verge of a
crisis had to ask for help from the International Monetary Fund.
The global financial system literally went into a cardiac
arrest after the Lehman Brothers Holdings Inc. collapse and a
meltdown was barely avoided through very aggressive policy
responses. So what lies ahead in 2009? Is the worst behind us or
ahead of us?
Unfortunately, the worst is ahead of us. The entire global
economy will contract in a severe and protracted U-shaped global
recession that started a year ago. The U.S. will certainly
experience its worst recession in decades, a deep and protracted
contraction lasting at least through the end of 2009. Even in
2010 the economic recovery may be so weak -- 1 percent growth or
so -- that it will feel terrible even if the recession is
technically over.

Recession Spreads

There also will be recessions in the euro zone, the U.K.,
continental Europe, Canada, Japan and the other advanced
economies.
A hard landing for emerging-market economies may also be at
hand. Among the so-called BRICs, Russia will be in an outright
recession in 2009. Growth in China will slow to 5 percent or
less, representing a hard landing for a country that needs
expansion of close to 10 percent to move 10 million to 15 million
poor rural farmers into the urban industrial sector every year.
Brazil will barely grow in 2009. Even India will experience a
sharp slowdown.
Most other emerging market economies will suffer a similar
hard landing. This severe global recession will morph into a
stag-deflation, a deadly combination of economic
stagnation/recession and deflation. In the advanced economies,
with aggregate demand falling below growing aggregate supply,
slack in goods markets will lead to deflationary pressures as
companies’ pricing power is restrained.
Likewise, rising unemployment will constrain labor costs and
wage growth. These factors, combined with sharply falling
commodity prices, will cause inflation in advanced economies to
ease toward negative territory, raising concerns about deflation.

Danger of Deflation

Deflation is dangerous as it leads to a liquidity trap:
nominal policy rates can’t fall below zero, so monetary policy
becomes ineffective and even quantitative easing may not work.
Falling prices mean that the real cost of capital is high
and the real value of nominal debts rise. This leads to further
declines in consumption and investment, thus setting in motion a
vicious circle in which incomes and jobs are squeezed,
aggravating the fall in demand and prices.
As traditional monetary policy becomes ineffective, other
unorthodox policies will continue to be used: policies to bail
out investors, financial institutions, and borrowers; massive
provision of liquidity to banks in order to ease the credit
crunch; and even more radical actions to reduce long-term
interest rates on government bonds and narrow the spread between
market rates and government bonds.

Triggering Event

Today’s global crisis was triggered by the collapse of the
U.S. housing bubble, but it wasn’t caused only by it. America’s
credit excesses were in residential mortgages, commercial
mortgages, credit cards, auto loans and student loans.
There were also massive excesses in the securitized products
that converted these debts into toxic financial derivatives; in
borrowing by local governments; in financing for leveraged
buyouts that should never have occurred; in corporate bonds that
will suffer massive losses as defaults surge; in the dangerous
and unregulated credit default swap market.
Moreover, these pathologies weren’t confined to the U.S.
There were housing bubbles in many other countries, fueled by
excessive and cheap lending that didn’t reflect underlying risks.
There was a commodities bubble and private-equity and hedge-funds
bubbles.

Shadow Banks

We now are seeing the demise of the shadow banking system,
the complex of non-bank financial institutions that looked like
banks as they borrowed short term and in liquid ways, leveraged a
lot, and invested in longer term and illiquid ways. As a result,
the biggest asset and credit bubble in financial history is going
bust, with overall credit losses likely to be more than $2
trillion.
Unless governments rapidly recapitalize financial
institutions, the credit crunch will become even more severe as
losses mount faster than recapitalization and banks are forced to
constrain credit and lending. Equity prices and other risky
assets have plunged from their peaks of late 2007, but there are
still significant risks for more declines.
An emerging consensus argues that the prices of many risky
assets -- including equities -- have fallen so much that we are
at the bottom and a rapid recovery will occur. But in the next
few months the macroeconomic news, the earnings and profits
reports, and the financial sector news from around the world will
be worse than expected. This will put more pressure on prices of
risky assets, with a chance of a 20 percent fall in global equity
prices.

Meltdown Averted

While the odds of a systemic financial meltdown have been
reduced by the actions of the Group of Seven and other economies,
severe vulnerabilities remain.
The credit crunch will persist and spread beyond mortgages.
Deleveraging will continue, as thousands of hedge funds -- many
of which will go bust -- and other leveraged players are forced
to sell assets into illiquid and distressed markets, thus causing
price declines and driving more insolvent financial institutions
out of business. Credit losses will mount as the recession
deepens. And a few emerging-market economies will certainly enter
a full-blown financial crisis.
So 2009 will be a painful year of global recession and
further financial stresses, losses and bankruptcies. Currently,
the probability of an L-shaped, stag-deflation is now rising to a
third, while the probability of a severe U-shaped recession is
two-thirds. Only aggressive, coordinated and effective policy
actions by advanced and emerging-market countries can ensure that
the global economy starts to recover -- however slowly --in 2010,
rather than entering a more protracted period of economic
stagnation.